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Should I Buy ConocoPhillips? 3 Pros, 3 Cons

A restructured COP is a much healthier one

   

ConocoPhillips‘ (NYSE:COP) “Investor Day” conference last week was pretty upbeat. In fact, analysts at JPMorgan (NYSE:JPM) put a $70 target on COP — roughly 20% above its current price — and noted that there could be acceleration in earnings in 2013.

That’s good, considering COP has been a laggard for the past year, returning just less than 2% in the past year vs. roughly 11% gains for the S&P 500. That’s thanks in part to pressure on oil prices, which has come amid volatility in the U.S. dollar and uncertainty in the global economy.

But could JPMorgan’s analysts be right? Should you buy ConocoPhillips with a reasonable expectation for a big move from here? Well, let’s take a look at the pros and cons:

Pros

Restructuring: ConocoPhillips underwent an aggressive M&A program during the past decade, but the results were far from good for shareholders. That’s why COP has done a complete change and has instituted a divestiture program. For example, the company unloaded underperforming assets like Cedar Creek Anticline and spun off its refining operations via Phillips 66 (NYSE:PSX), and now, COP essentially is just an exploration and production company. A key benefit of the restructuring has been an influx of cash totaling close to $12 billion. The restructuring also should allow for more managerial focus.

Production: Companies like ExxonMobil (NYSE:XOM), Chevron (NYSE:CVX) and Royal Dutch Shell (NYSE:RDS.A, RDS.B) have had troubles finding new reserves, and COP is no different, with 2013 looking like it will be a flat year for production. However, ConocoPhillips expects a much-healthier 3% to 5% growth rate over the next few years. COP has made substantial investments in the Gulf of Mexico; shale plays such as Eagle Ford, Permian and Bakken; and foreign markets, including China, Canada and Malaysia.

Dividend & Debt: COP has long-term debt of $21.7 billion, or 31% of equity. While that sounds high, it’s pretty reasonable considering interest rates are at rock-bottom levels and COP has been refinancing its debt to take advantage. The company also continues to generate substantial earnings ($6.7 billion in 2012) and funnels its cash back to shareholders. Last year, COP bought back $5.1 billion worth of shares and paid $3.3 billion in dividends; its current 66-cent quarterly payout equates to a hefty 4.6% yield.

Cons

Sensitivity: Because COP is now an E&P business — and is not diversified across other categories — the company is especially sensitive to movements in commodities prices. That’s not only worrisome in times of extreme volatility, but also when energy prices become depressed for prolonged periods, which was the case in the 1980s and ’90s. If this happens again, COP could be dead money for some time.

Environmental Liability: All you have to do is look at BP (NYSE:BP) and the Deepwater Horizon disaster to get an idea for how devastating this can be for an oil company. COP has indicated that it has invested more in safety and compliance, but these safeguards are far from foolproof, and COP still needs to explore in dangerous and remote areas to boost production. There are even liabilities with its shale plays, as state governments are looking at the possibility of groundwater pollution from fracking.

Politics: This is a big wild card. Foreign governments are getting more aggressive with oil companies, forcing onerous terms and higher fees and taxes. Plus you also have the risk of nationalization, which has occurred in Venezuela. Considering about 56% of COP’s production comes from outside the U.S., the company certainly is vulnerable to such actions.

Verdict

Following its restructuring, COP is a much different company now … and that’s a goo dthing. COP has a stronger focus and a solid balance sheet, and it should benefit from steady growth in production over the next few years.

Yes, oil prices have been weak this year, with crude falling to about $90 a barrel, but there are some big drivers for the long-term, including the expected rise of the global middle class, which will demand huge amounts of energy.

So, should you buy ConocoPhillips? Yes — given all these factors, and COP’s cheap 8x price-to-earnings ratio, the pros outweigh the cons.

Tom Taulli runs the InvestorPlace blog IPO Playbook. He is also the author of “How to Create the Next Facebook” and “High-Profit IPO Strategies: Finding Breakout IPOs for Investors and Traders.”Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/03/should-i-buy-conocophillips-3-pros-3-cons/.

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